Getting 20-somethings to jump-start their retirement savings
Cash Flow and Retirement
Whether your children (or grandchildren) are recent college graduates just starting their first job or have been employed and supporting themselves for several years, they may not be taking advantage of their employer-sponsored retirement plan. Unfortunately, for many 20-somethings, saving for retirement takes a backseat to other priorities.
While it may be difficult to get young people to focus on a retirement that may be 40 years or more away, those who get an early start on saving will be much better prepared to handle future financial challenges. To ensure your kids establish solid retirement saving habits early in their careers, consider incorporating the following topics into your own Retirement Savings 101 lesson plan.
Start saving now
If you can teach your kids to start saving for the future at an early age, they may someday raise a glass in your honor. That’s because young people have a built-in advantage over older investors — plenty of time.
Assuming their employer offers a matching contribution, your kids should — at a minimum — contribute enough to earn the full matching contribution from their employer. That provides a guaranteed immediate return on their investment, along with the potential for future tax-deferred growth. If they can afford to contribute more, then by all means they should do so. By saving as much as they can in the early years of their career, young adults can take full advantage of the “miracle” of compound growth.
Consider the example of a 25-year-old who sets aside $1,000 a year in a 401(k) plan and stops contributing at age 55, for a total contribution of $30,000. Assuming a 6% return compounded annually, that money would grow to more than $150,000 by age 65. In comparison, a 35-year-old who invests the same $1,000 a year for 30 years would accumulate only $83,802 by age 65. (This example is hypothetical and isn’t intended to predict the performance of any specific investment.)
Put savings on autopilot
Today, some employers’ plans automatically enroll new employees in the company’s 401(k) plan. If their employer doesn’t automatically enroll them, encourage your kids to sign up as soon as they’re eligible.
In most cases, contributions from employees who are automatically enrolled are invested in a target-date retirement fund* until they designate otherwise. A target-date fund, also known as a lifecycle, dynamic-risk, or age-based fund, invests in a mix of mutual funds that gradually becomes more conservative as the fund’s target date (usual retirement) approaches.
For example, a 22-year-old might have her contributions directed into a target-date fund that “matures” in the year 2055. Because time is on its side, a fund with a 2055 target date will often allocate as much as 90% of its assets to stocks today. This allocation will include domestic, international, and emerging-market stocks. (Investments in non-U.S. securities involve currency-fluctuation risk, and political or economic instability in the country in which the securities are issued can affect the value of those securities. Emerging-market securities can be highly volatile and speculative.)
The remaining 10% likely would be allocated to bonds. (Keep in mind that bonds involve varying degrees of default, market, and interest rate risks, with high yield bonds being speculative.) As the target date gets closer, the fund gradually will reduce its exposure to stocks and add exposure to lower-volatility offerings, such as bonds and money market funds. Bear in mind that the principal value of the fund isn’t guaranteed at any time, including at the target date.
While target-date funds provide an easy way to build an age-appropriate asset allocation, employees generally are free to opt-out and choose their own mix of funds. The key point young investors need to understand is that they typically should invest a healthy portion of their retirement savings in stocks. The road will get bumpy along the way, but with time on their side, young investors can afford to ride out the periodic market selloffs.
Share your wisdom (and mistakes)
Your children may not be eagerly anticipating your unsolicited financial pearls of wisdom and may even get defensive in response to questions about their personal finances. One way around this is to share some of your own youthful financial mistakes and what you learned from them. There’s no guarantee your kids will listen and learn. But if you’re able to instill an appreciation for disciplined saving habits, both you and your kids will be better off in the long run.
* There is no assurance that a target date fund will achieve its objective of moderating risk as the fund approaches its target date. Risk of loss is present throughout the target period. Funds which invest in other mutual funds are subject not only to the risks of the target fund but also to the special risks of the underlying mutual funds. Target funds may involve fees related to both the target fund and the underlying funds. Investments in equities have been volatile historically. Investments in fixed income securities fluctuate in value in response to changes in interest rates.
Which comes first? Retirement or student loans?
It’s increasingly common for college students to graduate with some form of debt. This leaves many wondering whether they should prioritize paying down their student loans over saving for retirement.
It’s generally advisable to enroll in an employer’s retirement savings plan as soon as possible, assuming the employer matches employee contributions, rather than making extra student loan payments. Of course, if your child’s take-home pay minus retirement contributions aren’t sufficient to meet required student loan payments and other expenses, retirement savings may have to wait.
But it may be possible to reduce expenses. Suggest your kids track their expenditures over the course of a month or two to see where their money goes. If your child can’t reduce expenses enough to start saving for retirement, his or her first raise or promotion may provide the additional income needed.